Documente Academic
Documente Profesional
Documente Cultură
Elisabeth A. Shumaker
Clerk of Court
No. 14-3086
-2-
Background
Alternate Fuels, Inc. (AFI) is a Kansas corporation that formerly engaged in
surface coal mining operations. On December 9, 1992, AFI filed a petition under
Chapter 11 of the Bankruptcy Code in the District of Kansas. AFI briefly
continued its coal mining operations under the terms of a confirmed plan of
reorganization. During this time, Larry Pommier was hired as AFIs field
engineer and financial cost analyst. In 1996, AFI ceased all mining operations
and abandoned its assets to various creditors. The Chapter 11 trustee who was
operating the reorganized debtor resigned.
At that time, John Warmack acquired 100% of the stock of AFI and
assumed control. Mr. Warmack became the sole director of AFI and appointed
Mr. Pommier as president. Mr. Warmack then formed Cimarron Energy Co., LLC
(Cimarron) to handle the mining operations for which AFI still held permits. Mr.
Warmack owned 99% of Cimarron, and Mr. Pommier owned 1%. Mr. Warmack
provided the State of Missouri with certain new reclamation bonds and
replacement reclamation bonds, which assured that AFI would restore permitted
-3-
with either AFI or Cimarron. Mr. Warmack used the $549,250 to pay down debts
of AFI secured by the Cimarron equipment Mr. Jenkins received. Note that the
certificates of deposit were assigned to Mr. Jenkins personallynot to AFI or
Cimarron. Mr. Jenkins has been receiving interest earned on the certificates since
his purchase of Mr. Warmacks interest in AFI.
Also on December 6, 1999, AFI executed, upon the signature of Mr.
Pommier, the first of the three promissory notes attached to Mr. Jenkins proof of
claim. I Aplt. App. 61. The note was in the amount of $500,000, payable to
Green Acres Farms, a fictitious business name Mr. Jenkins registered with the
State of Missouri. It bears the signature of Mr. Jenkins as witness.
The note states:
Principal balance plus accrued interest shall be due and payable five (5)
years from the date shown above. This note shall be paid in full upon
reclamation bond release from the State of Missouri. Said bonds currently
being used to secure reclamation liability for Alternate Fuels, Inc. at the
Blue Mound Mine.
Id. The note identified the underlying consideration as value received, and the
interest rate was 9.5%.
Mr. Jenkins was aware that AFI had no present ability to repay the note
from its own funds. However, as Mr. Pommier testified, if Mr. Jenkins received
the proceeds of the release of the certificates of deposit upon the completion of
reclamation, AFI would owe no money on the note. IV Aplt. App. at 697. Mr.
-5-
Jenkins testified that the released certificates of deposit were his only anticipated
source of future payment.
Cimarron held all of AFIs assetscomprised primarily of operating and
reclamation equipmentand conducted all of its activities. AFI had no income
other than advances provided by Mr. Jenkins through checks drawn on accounts
of Green Acres Farms. These checks were delivered to Mr. Pommier, who
endorsed them immediately for payment to Cimarron. The advanced funds were
never deposited into AFI accounts and were therefore never subject to the claims
of AFIs unpaid creditors. There was no contemporaneous accounting of the
advances; instead, annual worksheets enumerated his checks to AFI. VI Aplt.
App. 11521230.
On November 6, 2000, AFI executed a second promissory note in the
amount of $500,000 plus any future advances to Green Acres Farms or
Assigns. I Aplt. App. 64. The interest rate was 9%, and the notes terms were
otherwise identical to the previous note. Mr. Jenkins did not provide an
accounting to connect funds advanced by Green Acres Farms prior to the date of
the second note to the amount of that note. Mr. Jenkins again testified that he
knew AFI had no prospect of repaying this note from its own funds; his only
prospects for future payment were the certificates of deposit.
On October 11, 2001, Mr. Pommier executed a third promissory note in the
amount of $1,000,000 on behalf of AFI. I App. Aplt. 67. Mr. Pommier testified
-6-
that this note was a replacement for the two prior notes, which Mr. Jenkins
denied. The interest rate was 8%, and, again, the notes terms were otherwise
identical to the previous notes. Mr. Jenkins did not provide a contemporaneous
accounting to support the amount of the third note.
In 2002, AFI filed a lawsuit (the Cabanas suit) against certain state officers
and employees, alleging tortious interference with the completion of AFIs
reclamation process. Alternate Fuels, Inc. v. Cabanas, No. 4:02-cv-01182-JTM
(W.D. Mo. filed Dec. 23, 2002). Due to the cessation of reclamation efforts
pending the Cabanas suit, Mr. Jenkins saw that [his] chances of recovering on
AFIs certificates of deposit were diminishing. Aplt. Br. 17 (citing III Aplt.
App. 480). Thus, in exchange for Mr. Jenkins continuing to fund AFI and as
security for his loans, on March 1, 2003 AFI assigned $3 million of its potential
recovery to Mr. Jenkins. 1 Id.; I Aplt. App. 59.
On September 6, 2006, a judgment in the Cabanas suit was entered in favor
of AFI for actual damages of approximately $5.5 million and punitive damages of
$900,000. Following an appeal, and after payment of contingent attorneys fees
On the same date, a fourth note in the principal amount of $2.4 million
was executed. VI Aplt. App. 1151. It states that it is a renewal of the first three
notes, including accrued interest. The payment terms read: Principal balance
plus accrued interest shall be due and payable on or before five (5) years from the
date shown above . . . . This note shall be paid in full upon reclamation bond
release from the State of Missouri or proceeds from lawsuit filed in Federal Court
case no. 02CV1182. . . . Id. This fourth note is not included in Mr. Jenkins
proof of claim.
-7-
and costs, the recovery amounted to almost $5 million. News of the judgment
spread, and AFIs creditors began making claims against the judgment proceeds.
On January 28, 2009, AFI filed for a second bankruptcy for assistance in
determining the priority of payment.
Mr. Jenkins filed a proof of claim against AFIs estate in the amount of
$4.3 million. Id. at 57. The claim included $3.8 million for payment of the three
promissory notes, plus interest, secured by AFIs assignment of $3 million of the
Cabanas suit proceeds. 2 Although attachments to the proof of claim include a list
of the assigned certificates of deposit in the total principal amount of $1.4
million, these certificates are not included in the claim because they were
assigned to Mr. Jenkins personallynot to AFI. In addition to Mr. Jenkins
putative secured claim, there are several unsecured claims, totaling $5.7 million,
by various construction companies, insurance companies, and the State of
Missouri. Three of the largest unsecured claims arose before or during AFIs first
bankruptcy.
Exercising authority under 11 U.S.C. 105(a) and applying the Tenth
Circuits established test for recharacterization, the bankruptcy court found that
the transfers evidenced by the promissory notes underlying Mr. Jenkins claim
The court also found that the remainder of Mr. Jenkins claim, for
money related to reclamation and for accounts of Dan Card and Pat Miller,
should be recharacterized. In re Alternate Fuels, Inc., 2012 WL 6110429, at *12.
Mr. Jenkins does not appear to appeal the courts denial of this portion of his
claim.
-9-
Analysis
I.
reviews the decision of the bankruptcy court, applying the same standards of
review that govern appellate review in other cases. In re C.W. Mining Co., 749
F.3d 895, 898 (10th Cir. 2014). Whether a transaction labeled as a loan should
be recharacterized as an equity investment is a mixed question of fact and law.
In re Hedged-Investments Assocs., Inc., 380 F.3d 1292, 1297 (10th Cir. 2004).
We review the bankruptcy courts factual findings for clear error, but the
application of our legal test for recharacterization to those facts is a question of
law which we review de novo. Id. at 129798. We note that, in making its
factual findings, the court relied heavily upon the exhibits because the two
primary fact witnessesMr. Jenkins and Mr. Pommierwere not very credible.
In re Alternate Fuels, Inc., 2012 WL 6110429, at *2.
A.
First, we reject Mr. Jenkins argument that two recent Supreme Court
decisions implicitly overruled this courts precedent regarding the proper test for
determining when recharacterization is appropriate.
Although the Bankruptcy Code does not expressly address
recharacterization, we held in Hedged-Investments that the authority to
recharacterize putative debt as equity arises from a courts general equitable
- 10 -
- 11 -
- 12 -
105(a), a bankruptcy court has statutory authority to issue any order that is
necessary or appropriate to carry out the provisions of the Bankruptcy Code.
Id. at 1194. However, it is hornbook law that 105(a) does not allow a
bankruptcy court to override explicit mandates of other sections of the
Bankruptcy Code. Id. Because the bankruptcy courts order contravened an
express provision, 522, the court exceeded the limits of its authority under
105(a) and its inherent powers. Id. at 1195. Citing this analysis, Mr. Jenkins
argues that recharacterization under 105(a) is not permissible when it would
conflict with 502(b). Aplt. Br. 3940.
The Fifth and Ninth Circuits have rejected reliance on 105(a) as a source
of authority to recharacterize putative debt, and Mr. Jenkins urges us to follow
suit. These circuits have held that, to determine whether a particular obligation
owed by the debtor is a claim for purposes of bankruptcy law, a court must
simply determine whether that obligation gives the holder of the obligation a
right to payment under state law. In re Fitness Holdings Intl, Inc., 714 F.3d
1141, 114849 (9th Cir. 2013); see also In re Lothian Oil, Inc., 650 F.3d 539,
54244 (5th Cir. 2011).
We note that neither Travelers nor Law deal directly with
recharacterization. These cases do not mention recharacterization or discuss it in
any context, and they do not expressly overrule Hedged-Investments or any
recharacterization case from any other circuit. Further, Mr. Jenkins expansive
- 14 -
claim, a court must still determine the claims proper priority by scrutinizing
the true substance of a contested transaction. In re Dornier Aviation, 453 F.3d at
232. We therefore reject Mr. Jenkins contention that a courts power to
recharacterize arises solely from the disallowance provision of 502(b), rather
than from 105(a). Travelers and Law do not instruct otherwise. Travelers held
simply that claims enforceable under state law will be allowed in bankruptcy
unless they are expressly disallowed. Travelers does not prohibit a court from
proceeding to a second step in its analysis, to determine whether an otherwise
allowed claim fails in bankruptcy because it involves transactions properly
characterized as equity. And Law held simply that a court may not employ
105(a) to override other explicit mandates in the Bankruptcy Code. Here, no
explicit mandate of the Bankruptcy Code prohibits recharacterization under
105(a).
B.
Mr. Jenkins next argues that, even if the Hedged-Investments test applies, it
does not support recharacterization under the circumstances here. We agree.
In Hedged-Investments, we held that bankruptcy courts exercising authority
under 105(a) to recharacterize debt as camouflaged equity must apply a 13factor test. These factors, which reflect the characteristics of an arms length
negotiation, are:
(1)
(2)
the presence or absence of a fixed maturity date;
(3)
the source of payments;
(4)
the right to enforce payment of principal and interest;
(5)
participation in management flowing as a result;
(6)
the status of the contribution in relation to other corporate creditors;
(7)
the intent of the parties;
(8)
thin or adequate capitalization;
(9)
the identity of interest between the creditor and stockholder;
(10) the source of interest payments;
(11) the ability of the corporation to obtain loans from outside lenders;
(12) the extent to which funds were used to acquire capital assets; and
(13) the failure of the debtor to repay on the due date or to seek a
postponement.
Id. at 1298 (citing Stinnetts Pontiac Serv., Inc. v. C.I.R., 730 F.2d 634, 638 (11th
Cir. 1984)). The Hedged-Investments factors are not exclusive, and no single
factor is dispositive. Id. at 129899. Further, the test is a highly fact-dependent
inquiry. In re Dornier Aviation, 453 F.3d at 234. The significance of each
factor may vary depending on the circumstances. In re Hedged-Investments, 380
F.3d at 129899.
We begin by emphasizing that Mr. Jenkins was engaged in a venture with
substantial risk: he purchased equity in a struggling business with the singular
goal of completing reclamation and receiving the proceeds of the certificates of
deposit. When the business needed additional financial support to reach its goal,
Mr. Jenkins provided advances. We find nothing inherently improper about this
arrangement.
The bankruptcy court found that three of the Hedged-Investments factors
superficially support treating Mr. Jenkins advances as loans: the names given
- 17 -
the extent the Trustee questions their validity by arguing that the underlying
consideration was insufficient, Aplee. Br. 47, 51, his analysis is misguided. It is
true that there is no direct correlation between the worksheets enumerating Mr.
Jenkins checks to AFI and the amount of the notes. In re Alternate Fuels, Inc.,
2012 WL 6110429, at *5. For example, one accounting for the year 2000 shows
transfers of $710,906.16, VI Aplt. App. 1152, and another shows transfers of
$729,774.98, id. at 1189. The note dated November 6, 2000, for $500,000,
matches neither amount. The bankruptcy court found, however, that the note
amounts do roughly reflect the sums of Mr. Jenkins checks to AFI during the
prior year. In re Alternate Fuels, Inc., 2012 WL 6110429, at *11 (emphasis
added). 4
Regardless, the amount of a promissory note need not precisely correspond
to the amount of underlying transfers serving as consideration. This is because,
while a contract requires consideration to be valid, Kan. Stat. Ann. 16-107, in
general it need not have a value equivalent to the benefit received.
[C]onsideration legally sufficient for any purpose at all, even the slightest
consideration, is sufficient for whatever purpose the parties seek to use it. In re
Alternate Fuels, Inc., 2012 WL 6110429, at *17; 17A Am. Jur. 2d Contracts 115
(2015); see also State ex rel. Ludwick v. Bryant, 697 P.2d 858, 861 (Kan. 1985)
4
The court further found that the assignment of the Cabanas suit proceeds
as security for funds loaned to AFI was supported by adequate consideration
Mr. Jenkins promise to continue loaning money to AFI. Id. at *17.
- 19 -
concerning the twelfth factor, the bankruptcy court held that AFIs use of Mr.
Jenkins advances to fund operating expenses rather than to purchase capital
assetsindicating debtis irrelevant because AFI incurred no expenses other
than the funding of reclamation operations. This appears to be a tautology. AFI
necessarily made a choice between allocating Mr. Jenkins funds toward
operations or toward capital asset acquisition; it chose the former. This was an
obvious decision given AFIs narrow objectives but a decision nonetheless.
Additionally, we find no support for many of the bankruptcy courts other
findings in favor of recharacterization. For example, the court held that the ninth
factor, the identity of interest between the creditor and stockholder, suggests
equity. [I]f advances are made by stockholders in proportion to their respective
stock ownership, an equity contribution is indicated. In re Alternate Fuels, Inc.,
2012 WL 6110429, at *12 (citing Roth Steel Tube Co. v. C.I.R., 800 F.2d 625,
630 (6th Cir. 1986)). We agree this factor may indicate a capital contribution
when two or more shareholders own debt in the same proportion as their
underlying equity interests. See Bauer v. C.I.R., 748 F.2d 1365, 1370 (9th Cir.
1984) (comparing ratios of stock ownership and putative debt in the tax context).
Yet the same reasoning does not automatically apply when a single shareholder
owns the entirety of a companys stock. Otherwise, this factor would militate
against finding true debt in any situation involving a single stockholder. We see
no reason to assume that all funds transferred to a business owned by a single
- 21 -
Cimarron, id., and even if Mr. Jenkins did not subjectively believe that AFI
could repay the principal and interest from its own funds within five years, the
evidence indicates that he intended the notes to be satisfied pursuant to their
second clause: upon reclamation bond release by the State of Missouri. 5 Thus,
the courts finding cannot stand.
Certainly, the Trustee is correct that some of the Hedged-Investments
factors favor recharacterization. Most notably, the eleventh factor analyzes the
ability of the corporation to obtain loans from outside lending institutions.
When there is no evidence of other outside financing, the fact that no reasonable
creditor would have acted in the same manner is strong evidence that the
advances were capital contributions rather than loans. In re AutoStyle Plastics,
269 F.3d at 752. Here, despite Mr. Jenkins efforts to secure outside funding,
AFI was unable to obtain any other loans. And the thirteenth factor considers the
failure of the debtor to repay on the due date or to seek a postponement. AFI did
not pay the notes by their five-year maturity dates and did not seek an extension.
5
- 25 -
as the mining of coal. 6 In any event, we decline to question the value of any
particular endeavor. We are not empowered to pick winners and losers based
upon our view of the social utility of their underlying business.
The dissent also relies heavily on the source of repayment for the loans
which provided operating funds. But the promissory notes were to be repaid by
AFI when the payments were due: after five years or, at the latest, upon
completion of reclamation. That the payment ultimately was secured by the
certificates of deposit or by the Cabanas judgment does not allow us to recast debt
into a capital infusion.
Thus, considering all of the Hedged-Investments factors under the unique
circumstances of this case, we believe on balance that recharacterization of Mr.
Jenkins advances as capital contributions is not warranted.
II.
discharging Mr. Jenkins claim because he failed to meet his burden of persuasion
as to its amount. When a Trustee objects to a proof of claim, the creditor carries
the burden of persuasion as to the validity and amount of the claim. In re
Further, we will not presume that, at the time of Mr. Jenkins transfers,
AFI was a moribund business because it was engaged in reclamation. Dis. Op.
13 n.3. The future is full of uncertainties. One such uncertainty was the recovery
on a judgment.
- 26 -
Harrison, 987 F.2d 677, 680 (10th Cir. 1993). The bankruptcy court found that
Mr. Jenkins did not provide sufficient information to prove the amount of his
claim because neither the attachments to the proof of claim nor the trial evidence
is sufficient for the Court to determine the amount owed to the Jenkinses, if their
transfers to AFI are not recharacterized as equity. In re Alternate Fuels, Inc.,
2012 WL 6110429, at *17.
Yet, Mr. Jenkins attached to his claim valid copies of the three promissory
notes comprising his claim, as well as a copy of the assignment of the Cabanas
suit proceeds. Both the Trustee and the bankruptcy court accepted the facial
terms of the notes and assignment, and the Trustee has not argued that Mr.
Jenkins interest calculations are inaccurate. The Trustee focuses again on
whether Mr. Jenkins advances to AFI directly correlate to the note amounts,
Aplee. Br. 47, but such an inquiry is not necessary. Because, as discussed above,
we decline to recharacterize the underlying transfers as equity rather than debt,
the amount of AFIs indebtedness to Mr. Jenkins under the notes is crystal clear.
The dissent points out that, in concluding Mr. Jenkins did not sustain his
burden of proof as to the validity and amount of his claim, the bankruptcy court
did not address its status as a secured claim. This issue was not raised directly by
the parties, 7 and we decline to venture off-brief to address arguments the parties
Thus, the Trustee merely repeats arguments about the validity and
amount of the notes that we have rejected. Aplee. Br. 47.
- 27 -
have not presented or provide relief the parties have not requested. In re C.W.
Mining Co., 625 F.3d 1240, 1246 (10th Cir. 2010); see Fed. R. App. P.
28(a)(5)(9).
III.
the subordinated creditors right to repayment until others claims have been
satisfied. In re Hedged-Investments, 380 F.3d at 1297 (citing In re Mid-Town
Produce, 599 F.2d at 39394).
We note that equitable subordination is an extraordinary remedy to be
employed by courts sparingly. Wrongful or unpredictable subordination spawns
legal uncertainty of a particular type: the risk that a court may refuse to honor an
otherwise binding agreement on amorphous grounds of equity. In re Lifschultz
Fast Freight, 132 F.3d 339, 347 (7th Cir. 1997).
The Tenth Circuit requires three conditions for a court to exercise its
equitable subordination power: (1) inequitable conduct on the part of the
claimant sought to be subordinated; (2) injury to the other creditors of the
bankrupt or unfair advantage for the claimant resulting from the claimants
conduct; and (3) consistency with the provisions of the Bankruptcy Code. In re
Hedged-Investments, 380 F.3d at 1300. We place special emphasis on whether
inequitable conduct has occurred, id. at 1300, and recognize three categories of
such conduct: (1) fraud, illegality, and breach of fiduciary duties; (2)
undercapitalization; or (3) claimants use of the debtor as a mere instrumentality
or alter ego, id. at 1301 (quoting In re Fabricators, Inc., 926 F.2d 1458, 1467
(5th Cir. 1991)). A majority of courts have described the degree of inequitable
conduct warranting subordination as gross and egregious, tantamount to fraud,
- 29 -
Mr. Jenkins contests, Aplt. Br. 6263, helping AFI fulfill obligations owed to the
State of Missouri does not constitute a breach of those duties. Indeed, at the time
Mr. Jenkins purchased AFI, it was no longer engaged in active mining operations,
and its only pursuit was to reclaim permitted lands.
Furthermore, the court did not find that Mr. Jenkins controlled AFI as an
instrumentality or mere alter ego, and the Trustees argument to the contrary is
unpersuasive. We decline to hold broadly that a company becomes the alter ego
of its majority shareholder simply because that shareholder funds a project that
will ultimately benefit him. And, although AFI was thinly capitalized,
undercapitalization is not in itself inequitable conduct. In re HedgedInvestments, 380 F.3d at 1302 (quoting In re Lifschultz Fast Freight, 132 F.3d at
345). A dearth of capital resources increases risk for a lender, but the lender
typically will have adequate information about such risk unless trickerysuch
as the exploitation of secret information or misrepresentation of the borrowers
financial healthupsets ordinary market forces. Id. at 130203.
Applying the less stringent insider standard, the bankruptcy court highlights
several of Mr. Jenkins specific actions as unfair. Although perhaps atypical,
none of these acts are unfair. For example, Mr. Jenkins arranged for a straw
man to hold his interest in AFI because he was listed in the Applicant Violator
System (AVS) of the federal Office of Surface Mining, Reclamation, and
Enforcement and therefore blocked from being an owner or operator of a coal
- 31 -
mining operation in the United States. Yet, Mr. Pommier conceded that Mr.
Jenkins AVS status would not have actually prevented or in any way affected his
purchase of AFI, since he did not intend to operate the mining business but
simply complete reclamation. Additionally, Mr. Jenkins only adopted the straw
arrangement upon Mr. Pommiers advice. IV Aplt. App. 645.
The court also noted that Mr. Jenkins failed to account for certain sales of
AFIs or Cimarrons assets. In re Alternate Fuels, Inc., 2012 WL 6110429, at
*14. Mr. Pommier alleges that Mr. Jenkins pocketed the sales proceeds, and the
court found that Mr. Jenkins did not adequately refute this conclusion. Instead, it
held that Mr. Jenkins probably retained the proceeds for his own benefit
without applying a credit to the notes. Id. at *5. Given that the court found
neither Mr. Pommier nor Mr. Jenkins testimony to be reliable and the record
evidence does not provide clarity, a claim of even probable unfair conduct
should not serve as the basis for the extreme remedy of equitable subordination.
Furthermore, the court relied heavily on its recharacterization analysis in
holding that Mr. Jenkins acted unfairly. The court highlighted that Mr. Jenkins
loans to AFI were in fact substitutions for equity or risk capital. Id. at *14.
As discussed above, we hold that Mr. Jenkins loans to AFI were indeed loans;
thus, he did not act unfairly when executing the promissory notes. In fact, AFI
would not have been able to complete reclamation without the funds advanced by
Mr. Jenkins. Similarly, the assignment of the Cabanas judgment was not
- 32 -
- 33 -
I. Recharacterization
I begin by recognizing a simple fact: Mr. Jenkins was not funding Alternate Fuels,
Inc. (AFI) to keep a struggling business afloat in hopes that it might later make money.
Instead, for his financial benefit and not AFIs, he funded AFI solely so that it could meet
its obligation to reclaim coal lands in accordance with its promise to the State of
Missouri. In short, by buying AFI, Mr. Jenkins made a business gamblehe bet that he
would spend less helping AFI reclaim the coal land than he would make from his
collecting 24 certificates of deposit worth about $1.4 million that he had bought from
AFIs previous owner, Mr. Warmack, who had pledged the certificates of deposit against
the reclamation bonds. See In re Alternate Fuels, Inc., Bankr. No. 09-20173, 2012 WL
6110429, at *3 n.6 (Bankr. D. Kan. Dec. 10, 2012) (unpublished) (In re Alternate Fuels
I). Also as part of his business calculation, Mr. Jenkins knew that by buying AFI he was
also obtaining Cimarrons equipment (of which his purchased share was 99%) worth
between one and two million dollars. See In re Alternate Fuels, Inc., 507 B.R. 324, 328
29 (B.A.P. 10th Cir. 2014) (In re Alternate Fuels II).
As noted in In re Hedged-Investments Assocs. Inc., 380 F.3d 1292, 1297 (10th Cir.
2004), when a bankruptcy court recharacterizes a loan, it effectively ignore[s] the label
attached to the transaction at issue and instead recognize[s] its true substance.1 The
effect is that [t]he funds advanced are no longer considered a loan which must be repaid
in bankruptcy proceedings as a corporate debt, but are instead treated as a capital
contribution. Id. In evaluating whether funds advanced to a now-bankrupt entity were
true loans or camouflaged equity investments, we consider a nonexclusive list of
thirteen factors:
(1) the names given to the certificates evidencing the indebtedness;
(2) the presence or absence of a fixed maturity date;
(3) the source of payments;
(4) the right to enforce payment of principal and interest;
(5) participating in management flowing as a result;
(6) the status of the contribution in relation to regular corporate creditors;
(7) the intent of the parties;
(8) thin or adequate capitalization;
(9) identity of interest between the creditor and stockholder;
For all reasons advanced in the majority opinion, I agree that In re HedgedInvestments remains good law even after the decisions in Travelers Cas. & Surety Co. of
Am. v. Pac. Gas & Elec. Co., 549 U.S. 443 (2007), and Law v. Siegel, 134 S. Ct. 1188
(2014).
2
diverts the analysis in the wrong direction, miscasting Mr. Jenkins in a role unfitting him
hereas an owner trying to help his business survive during a tough time. When such a
business owner brings a case to us, we can consider it under our 13 factors independently
of whatever result we reach for Mr. Jenkins based on his far different circumstances.
lawsuit, contemplates possible payment before five years have passed from execution of
the notes. Supporting this view that the two contingencies did not indeterminately extend
the due date past five years, I read the contingencies as being consistent with the fourth
notes direction that the [p]rincipal balance plus accrued interest shall be due and
payable on or before five (5) years from the date shown above. . . . Appellants App.,
vol. VI, at 1151 (emphasis added).
c. Factor 4: The right to enforce payment of principal and interest
I agree with the majority that Mr. Jenkins had a right to enforce payment on his notes
regardless of whether AFI had any assets. In my view, as in the majoritys, it is
unimportant under this factor that Mr. Jenkins did not exercise his contractual right to
enforce payment when it became due. Maj. Op. at 22. I agree with the majority that [t]he
fact that he did not exercise this contractual right does not render it meaningless. Id. In
my view, the bankruptcy court confuses Mr. Jenkinss right to enforce payment with
his ability to do so. Because the factor does not ask about the debtors ability to pay,
the bankruptcy court erred by discounting this factor because in its view the right was
illusory. In re Alternate Fuels I, 2012 WL 6110429, at *11.
2. Is there a reality of debt based on the conduct, knowledge, and intent of the
parties?
a. Factor 3: The source of the payments
The majority does not discuss this factor. The bankruptcy court does though,
concluding that it strongly indicates a capital infusion. Id. at *11. The question is
whether the lender has any reasonable expectation of payment if the business fails. In re
5
Lexington Oil & Gas Ltd., Co., 423 B.R. 353, 366 (Bankr. E.D. Okla. 2010). In
evaluating this question, the bankruptcy court found that AFI had no business other than
the completion of reclamation, which reclamation would not generate revenue for AFI,
but it would result in the release of the Certificates of Deposit which were assigned to the
Jenkinses and were looked to by the parties as the source of payment of the Notes. In re
Alternate Fuels I, 2012 WL 6110429, at *11. When we eliminate the certificates of
deposit as a source of repayment of the three loans because they already belonged to Mr.
Jenkins, no source of repayment remained. In that setting, I agree with the bankruptcy
court that this factor favors a finding of investment equity and not loans.
b. Factor 5: Participation in management flowing as a result
Because Mr. Jenkins did not increase his participation in management because of the
asserted debt AFI owed on the promissory notes, the majority contends that this factor
favors Mr. Jenkins and a finding of loans. I am unpersuaded. We must remember that Mr.
Jenkins owned one-hundred percent of AFI and could manage it as he pleased. I cannot
see how his inability to manage it beyond one-hundred percent favors either sides
argument. In that situation, I say this factor is neutral and favors neither side.
c. Factor 6: The status of the contribution in relation to regular corporate
creditors
The majority ignores this factor, and the bankruptcy court deemed it irrelevant. See id.
at *10. I do not weigh it in favor of either party.
owned certificates of deposit. And if the majority indeed reads this promissory-note
language as requiring repayment from the certificates of deposit, the bankruptcy court on
remand should first apply the $1.4 million against Mr. Jenkinss proof of claim before
looking to AFIs other assets.2
The fourth note incorporates and cumulates the principal and interest owed on the
first three notes. But any debt owed on the first three notes was old debt. While the
bankruptcy court and majority agree that consideration (the promise to provide further
funds to reclaim the coal property) supported the fourth note, I believe that consideration
would support only a loan for newly lent money, not for money already lent and spent.
Before I could agree that Mr. Jenkins can so easily cut ahead of AFIs other creditors, I
would need to see some legal justification allowing it. Absent that, I believe the intent of
the parties favors a finding that the loans in reality were equity investment.
e. Factor 8: Thin or inadequate capitalization
The majority finds no support for the bankruptcy courts conclusion that this factor
favored recharacterization. Maj. Op. at 21. Instead, the majority suggests that the
bankruptcy court placed too heavy an emphasis on undercapitalization in using this factor
to favor recharacterization. See Maj. Op. at 23. No one disputes that AFI was
inadequately capitalized to engage in coal mining. Its lack of capital or any other assets
certainly made any repayment unrealistic. I agree with the majority that heavily
2
Mr. Jenkins sought outside lending to fund the reclamation, but no outside lenders
were willing to lend money. Had an outside lender been found, it would have made sense
that its promissory note would have included the certificates of deposit as collateral.
Whether the promissory notes here are a vestige of that earlier lending attempt is
unknown from the record.
8
h. Factor 12: The extent to which the advance was used to acquire capital
assets
The bankruptcy court says that this factor superficially weighs in favor of a loan
because Mr. Jenkinss money was used to fund operating expenses and not to acquire
capital assets. Id. at *10. It gives this factor reduced significance because AFI in
reclamation-mode had only operating expenses and did not acquire capital assets. Id.
Even so, the factor itself does not delve into the reasons a business expends funds one
way or the otherit simply asks how they were spent. Because the funds here were spent
on operating expenses, I agree with the majority that this factor weighs in favor of debt,
although not nearly so much as in an ordinary ongoing-business situation.
Finally, this brings us to two factors the majority concedes support the bankruptcy
courts view that the Jenkins loans were equity investment and not loans.
i. Factor 11: The ability of the corporation to obtain loans from outside
lending institutions
The majority notes that Mr. Jenkins tried and failed to obtain loans from outside
lending institutions on behalf of AFI. Maj. Op. at 23. It further observes that [w]hen
there is no evidence of other outside financing, the fact that no reasonable creditor would
have acted in the same manner is strong evidence that the advances were capital
contributions rather than loans. Maj. Op. at 24 (quoting In re AutoStyle Plastics, Inc.,
269 F.3d 726, 752 (6th Cir. 2001)). In view of AFIs financial condition, Mr. Jenkinss
failure to find outside lenders was hardly a surprise. This factor supports the bankruptcy
courts decision recharacterizing Mr. Jenkinss loans as investment equity.
10
j. Factor 13: The failure of the debtor to repay on the due date or to seek a
postponement
The majority agrees that this factor favors recharacterization because AFI did not
pay the notes by their five-year maturity dates and did not seek an extension. Maj. Op. at
24. Again, it is not just the failure to pay that weighs in favor of investment equity and
against loans. It is also why AFI did not pay. Quite simply, AFI had no ability to pay the
debts when due, and Mr. Jenkins knew when he wrote the promissory notes that this
would happen. Again, this factor supports the bankruptcy courts decision to
recharacterize the loans as investment equity.
11
In concluding otherwise, the majority relies on a policy of encouraging (or at least not
discouraging) hypothetical business ownersunlike Mr. Jenkinswho lend their
businesses money to keep them running in hopes of future profits. In this regard, the
majority urges caution on grounds that [w]e have been careful not to discourage owners
from trying to salvage a business by requiring all contributions to be made in the form
of equity capital. Maj. Op. at 25 (quoting In re Mid-Town Produce Terminal, Inc., 599
F.2d 389, 392 (10th Cir. 1979)). Similarly, it notes that [i]ndeed, owners may often be
the only party willing to make a loan to a struggling business, In re Dornier Aviation
[(North America), Inc.], 453 F.3d [225,] 234 [(4th Cir. 2006)], and needlessly punishing
their efforts is neither desirable as social policy nor required by our precedent. In re
Mid-Town Produce, 599 F.2d at 392. Maj. Op. at 25.
While those are sensible policies in those sorts of cases, this case does not fit that bill.
Here, Mr. Jenkins was in no way lending to sustain or revive a struggling business.
Giving him the benefit of policies assuming that he was doing so skews the HedgedInvestments analysis. Thus, I disagree with the majority that the unique circumstances of
this case justify treating Mr. Jenkinss money advances as loans under HedgedInvestments. Maj. Op. at 26. Instead, I believe that the actual circumstances here (Mr.
Jenkinss advancing AFI money not to mine coal but instead to reclaim coal lands so Mr.
Jenkins could obtain release of his certificates of deposit) favor recharacterizing the loans
as equity investment.3
I do not agree with the majority that any of my analysis would mean that we are
empowered to pick winners and losers based upon our view of the social utility of their
12
underlying business. Maj. Op. at 26. Few would doubt the social utility of reclaiming
lands used for coal mining. Instead, what the analysis suggests is that a business owner
funding a struggling business is more apt to intend to seek repayment on his advanced
funds than a business owner like Mr. Jenkins who lent money to an otherwise moribund
business with his own independent financial incentive without hope of the moribund
business ever paying him back.
4
The bankruptcy court referenced the objection on the three bases asserted by the
Trustee. Alternate Fuels I, 2012 WL 6110429, at *17.
13
decision on the issue, a decision we could later more meaningfully review. Because the
majority prefers to press ahead, I will simply note my concerns and their bases.
Before a security interest may be enforced against the debtor, certain formal
requirements must be met.5 Maxl Sales Co. v. Critiques, Inc., 796 F.2d 1293, 1297 (10th
Cir. 1986) (applying Kansas law to determine whether a creditor in a bankruptcy
proceeding had a secured interest). First, the debtor must have signed a written security
agreement that provides a description of the collateral. Kan. Stat. Ann. 84-9203(b)(3)(A). Second, the creditor must give value. Id. 84-9-203(b)(1). Third, the
debtor must have rights in the collateral. Id. 84-9-203(b)(3)(A). Here, a remand would
help us tell whether these conditions are met. Because the majority reverses the
bankruptcy courts holding that the loans should be recharacterized as investment equity
and not debt, the unsecured creditors have a great interest in knowing whether AFI is a
secured or unsecured creditor.
In my view, based on the record, the fourth promissory note likely does not meet the
requirements of a security agreement under Kansas law. I note that Mr. Jenkins did not
even include this renewal note as part of his proof of claim. Nor do I see why he would
Section 101 of the Bankruptcy Code defines security agreement (agreement that
creates or provides for a security interest), security interest (lien created by agreement),
and lien (charge against or interest in property to secure payment of a debt or
performance of an obligation). 11 U.S.C. 101(50), (51), and (37), respectively. The
definitions section of the Kansas secured transactions statutes defines secured party as
a person in whose favor a security interest is created or provided for under a security
agreement, whether or not any obligation to be secured is outstanding. Kan. Stat. Ann.
84-9-102(a)(71)(A). And it has the same definition for security agreement as the
Bankruptcy Code. Id. 84-9-102(a)(72).
14
have done soin my view, the fourth promissory note does not describe as collateral
either the Cabanas lawsuits possible judgment proceeds or the $3 million Cabanas
lawsuit assignment. Instead, as I read its terms, the renewal note simply adds an
additional time before five years have elapsed at which payment might become due. By
my reading, the note sets an outer limit of five years in which to pay, and provides two
possible earlier payment due datesupon reclamation bond release by the State of
Missouri or upon . . . proceeds from the [Cabanas] lawsuit. . . . This fourth note
(March 1, 2003) contains the stock language of the three earlier notes, but it adds the
language I italicize below:
Principal balance plus accrued interest shall be due and payable on or
before five (5) years from the date shown above at Route 2 Box 97 Adrian,
Missouri 64720. This note shall be paid in full upon reclamation bond
release from the State of Missouri or proceeds from lawsuit filed in Federal
Court case no 02CV1182 said bonds currently being used to secure
reclamation liability for Alternate Fuels, Inc. at the Blue Bound Mine.
Appellants App., vol. VI, at 1151 (emphasis added).
I cannot see how this language creates a security interest in collateral of the
certificates of deposit or of assignment of the Cabanas lawsuit proceeds. First, for the
certificates of deposit, any such reading would make no sense. As the majority notes, Mr.
Jenkins, and not AFI, personally owns the $1.4 million dollars in certificates of deposit.
Maj. Op. at 5. Surely AFI was not to pay its substantial debt to Mr. Jenkins from his own
property. Second, as with the certificates of deposit, this language does not say that Mr.
Jenkins is entitled to repayment from the proceeds from lawsuit. Instead, Mr. Jenkinss
noteand we should remember he wrote itprovides that the note was due upon
15
proceeds from lawsuit. In my view, Mr. Jenkinss word choice of upon instead of
from fails to identify collateral in a security agreement. Instead, it simply identifies an
alternative, earlier moment in time when payment might become due.
Nor does the 2003 renewal note identify as collateral the $3 million assignment AFI
made to Mr. Jenkins that same day. Similarly, the assignment does not mention the
renewal note. This complicates any effort to combine the two instruments to fashion or
find a security interest in the identified collateral. I see nothing in any promissory note
describing collateral sufficiently to satisfy Kan. Stat. Ann. 84-9-203(b)(2).
Because the 2003 renewal note and the Cabanas assignment are distinct, Mr. Jenkins
must attempt to recover from them separately. Even with the majoritys decision not to
recharacterize the loans as equity, Mr. Jenkins still should be left to recover from his
promissory notes as part of the group of unsecured creditors. As for the Cabanas lawsuit
assignment, [t]he general rule is that an assignee of a nonnegotiable chose in action
acquires no greater right than was possessed by his assignor, and simply stands in the
shoes of the latter. Carson v. Chevron Chem. Co., 635 P.2d 1248, 1260 (Kan. Ct. App.
1981); see also 6 Am. Jur. 2d. Assignments, 108 (2d ed. 2015) (As a general rule, an
assignee takes the subject of the assignment with all the rights and remedies possessed by
or available to the assignor.). For these reasons, I respectfully dissent.
16